Melrose Regulatory News (MRO)

Please see the exchange of letters (below) between the Secretary of State for Business, Energy and Industrial Strategy, the Rt Hon Greg Clark, and Melrose Industries Plc.

For investor enquiries, please contact:

BEIS Commercial Advisory and Investor Relations (CAIR)

Investor_relations@beis.gov.uk

For media enquiries, please contact:

Alec James in the BEIS Press Office

Alec.james2@beis.gov.uk

Letter from the BEIS Secretary of State to the Melrose Chief Executive

26 March 2018

Dear Mr Peckham,

Thank you for meeting me on Thursday following the engagement you have had with officials in my Department and others across Government since our first conversation on 13 January, the day after you launched your bid for GKN.

As I explained, my quasi-judicial role requires me to treat all parties fairly and so I should disclose that I have had similar conversations with the Chief Executive of GKN and have also had a briefing from the Chief Executive of Dana Inc, which has been proposed as a partner in a transaction with GKN.

As you know, the Enterprise Act 2002 gives power to the Secretary of State, acting in a quasi-judicial role, to refer to the Competition and Markets Authority a takeover bid which gives rise to concerns over media plurality, national security and financial stability. In these matters I will be advised, as you will expect, by my colleagues at the Ministry of Defence and other expert bodies.

Broader stakeholder interests

In addition to this statutory role, as Business Secretary I have a wider concern that, where important businesses are involved, takeovers should not act against the interests of our economy, employees or the broader set of stakeholders. GKN is a valued employer - directly and through its supply chain - and plays an important role in Britain's automotive and aerospace sectors, and, through its research and development, has a vital part to play in our Industrial Strategy. It also benefits from Government-sponsored contracts and participates in sectors which enjoy active engagement from Government-sponsored research and development. It also carries responsibility for a large number of pensioner stakeholders who depend on GKN's prosperity to fund the pension scheme which is currently in deficit.

Section 172 of the Companies Act sets out a statutory requirement for directors to have regard to, amongst other things, the interests of the company's employees; the company's business relationships with suppliers, customers and others; and the impact on the community and the environment. In my view, this establishes the principle that we expect interests broader than pure shareholder value should be taken into account by Directors and in the attitude of the Government.

In the past, some takeovers have had consequences for these wider groups that were not only deleterious but also at odds with indications given during takeover bids.

For this reason, a new regime has been established in which bidding companies can make binding commitments as to their intended conduct in the event of the bid succeeding.

Having established this regime, I believe that it should be used in takeover bids where the interests of these stakeholders are engaged, as is clearly the case here, and I would expect such commitments given to be extensive and clear. 

The need for a long-term approach

In this case I am also mindful of the business model which Melrose operates and its history of acquiring, improving and selling businesses. Whilst this approach can have an important and beneficial role to play, tensions could arise between this approach and the need for long-term investment and stability. The public should reasonably expect that companies that benefit directly or indirectly from long-term public sector contracts or indirectly from Government-supported long-term research and development should be willing and able to adopt appropriate time horizons on investment decisions.

Areas to be addressed

In our discussions and during the meetings with officials in my department over the last few weeks we have therefore raised a number of areas in which clear commitments will be important. These commitments, which would need to be binding in the event that your bid was successful, include:

· Operating as a UK business, headquartered and listed in the UK

· Maintaining a UK workforce and respecting the existing employment rights of that UK workforce, as well as closely engaging with their representatives

· Continuing to pay tax as a UK taxpayer

· Continuing to invest in research and development programmes, such as eDrive and the Wing of the Future, which are crucial to our Industrial Strategy

· Investing in the training and development of the workforce, including in apprenticeships

· Treating suppliers well, including prompt payment for suppliers

· Making arrangements for current and future pensioners which are to the satisfaction of trustees and the independent pensions regulator

You have indicated to me that you would be willing to respond to the points we have raised by addressing these issues by providing relevant undertakings and given the advanced state of the takeover timetable I feel it would be timely to now do so.

GKN's defence work

As is well known, GKN plc is a longstanding supplier of components and services directly, and through a chain of suppliers, to the British Armed Forces and to security bodies in some of our allies. 

As the Defence Secretary said, in evidence to Parliament, we need clarity on the approach from Melrose, and on the duration of their intended period of ownership. I too believe it is important that security sensitive suppliers to Her Majesty's Government are able to make long-term commitments to supply and take a long-term view of investment decisions. I believe a stable ownership and financing structure is an important part of the underpinning for these trusted relationships. That stability is also important for research and development partnerships which by their nature endure over many years. 

I recognise that any listed company may be subject to future takeover and so cannot guarantee its ownership indefinitely.

However, I am concerned that a short-term approach to ownership may not be compatible with maintaining the longer-term relationships which characterise the best interests of the defence field. In the light of this I would expect to see a commitment to continuity of ownership and strategic investment specific to the defence related business of GKN and to exclude the option of a short-term sale of this business without the consent of the Government. I am aware that you are separately discussing with the Ministry of Defence the terms of an agreement that would satisfy any concerns that the Defence Secretary may have.

Next steps

I want to be clear that the Government is committed to an open economy and to the belief that in most regards markets and shareholders should decide the outcome of takeover bids. Where however there are broader interests at play and in particular where public investment is directly or indirectly at stake I do expect potential acquirers to reflect these in their approach and the commitments they are prepared to make. 

Whilst I am appreciative of the time you and your board have taken to engage with us on these matters I believe that it would now be in the general public interest to set out Melrose's preparedness to address these matters before the bid closes formally. This would help inform shareholders and the public as to the Company's intentions on the wider matters, and, for those aspects that are relevant to it, to inform my consideration of whether the bid gives rise to concerns relating to national security.

I await your early response.

THE RT HON GREG CLARK MP

Secretary of State for Business, Energy & Industrial Strategy

Letter from the Melrose Chief Executive to the BEIS Secretary of State

27 March 2018

Dear Secretary of State,

Further to our meeting on 22 March and your letter dated 26 March, I write to draw together in one letter to you our strong commitment to create a £10 billion UK engineering and manufacturing powerhouse and returning GKN to its rightful place, competing on the world stage.

We buy good but underperforming manufacturing and engineering businesses and improve them to the benefit of all stakeholders. This letter follows helpful discussions with your Department, Ministry of Defence, Parliament, GKN's pensions trustees, Unite and the various regulatory bodies involved.

We have been working hard to ensure we are able to be as clear as possible about our ambition and intentions for GKN, and to make sure that we act in the best interests of all stakeholders should we acquire the business. Unfortunately, as a result of the nature of the transaction, we have not had access to the information we would expect in order to make detailed commitments.

Nonetheless, our commitment throughout has been clear.

Although we set out a number of undertakings and intention statements in our letter to the Business, Energy and Industrial Strategy Select Committee, we recognise the concerns you have raised with us and have sought to provide further commitments to address these.

Industry

We are a British listed company that is focused on improving the good but underperforming businesses we acquire. We invest in R&D. We invest in our people, in skills and training. We boost productivity. It is partly through this investment that we make the operational improvements and productivity gains that are central to our strong track record.

Takeover Panel enforceable undertakings

We have been able to agree with the Takeover Panel the form of the following legally enforceable undertakings:

· For a period of five years, Melrose will:

o maintain its UK listing;

o maintain its UK headquarters;

o ensure a majority of its directors are resident in the UK; and

o ensure that the Aerospace and Driveline divisions retain the rights to the GKN name;

· Melrose will at least maintain GKN's current level of expensed research and development investment equal 2.2% of sales over the financial years 2019, 2020, 2021, 2022 and 2023.

These undertakings are enforceable by, and have been agreed with, the Takeover Panel pursuant to the Takeover Code.

However, our ambitions for GKN's businesses go beyond the commitments we have been able to agree with the Panel. Therefore, we have set out further commitments below outside the regime of the Takeover Code.

A long-term commitment

We are a great British success story and are totally transparent about our ambitions and intentions. We are here because under the management of its current board, GKN has underperformed its potential and its peers and the business needs help. We believe we are the right team to return this ailing business to once again become a British engineering and manufacturing powerhouse, competing on the world stage, for the benefit of all stakeholders.

With our understanding of the challenges facing GKN, we anticipate that their improvement period under our ownership will extend for a number of years. Throughout, we would invest as if we were going to own these businesses forever to make them as successful as possible. We do this because it is the right thing to do, but also because it is in the best interests of our investors and other stakeholders. It is fundamental to our core business philosophy and is the best way to maximise value. We have no set sale deadline and can hold a business for as long as we consider appropriate for the improvement profile of the particular business. Once we have improved GKN's businesses, we will review all strategic options as to what would be best for the next stage of development for each business.

To demonstrate the strength of our commitment and ensure that its improvement and investment programme is not unduly interrupted, we are willing to make a legally binding commitment to you (or in the form of a post offer undertaking, if permissible under the Takeover Code) that, subject to below, Melrose will not sell the Aerospace Division before 1 April 2023.

This undertaking would not apply to any of the non-material or non-core businesses as already identified by GKN or where required by any competent overseas regulatory authority or under a pre-existing obligation, nor would it prohibit the flotation of Aerospace on the UK stock market. In addition, should we be approached by a suitable strategic purchaser offering a long-term ownership and investment proposal for Aerospace prior to 1 April 2023, we would ask that you consider in good faith, with the advice of your Department, the approval of such a proposal.

Although flexibility is an important part of the Melrose business model that is well understood and supported by our shareholders, we hope that this will demonstrate our commitment to the UK industrial base and is in direct contrast to the fire-sale being undertaken by the current GKN board.

Creation of a Skills, Innovation and Productivity Fund

Our commitment to skills, innovation and productivity is clear. Based on 2017 sales of approximately £10 billon, the Takeover Code undertaking above would have equated to an investment in R&D of £220 million in 2017, or £1.1 billion across five years. However, we consider this 2.2% commitment to be a floor, not a ceiling on our ambitions.

Because we believe in building Britain's industrial base, and because we invest for the long-term regardless of how long we own our businesses for, we will also create a new Melrose skills, innovation and productivity fund.

Going beyond our Takeover Code undertaking to invest 2.2% of sales in R&D, we will make a further £10 million available over five years to support the creation of between 100 to 150 new apprenticeships in engineering, technology and science.

The investment will be directed by a new Melrose Skills Board made up of UK representatives from the enlarged Melrose Group, including GKN Driveline and GKN Aerospace. We will appoint an independent chair with experience in high-end skills to ensure the funding is directed as effectively as possible. The funding will be available to support our businesses, but will also be available to higher education colleges around both businesses in the South West, Midlands and Oxford to create new opportunities for young people in those regions and help foster the next generation of great British engineers.

In addition, while much has been rightly made of the importance of eDrive technology, in reality we understand that little of the development or manufacturing of this technology by GKN is currently located in the UK. Although GKN opened an innovation centre in Abingdon, Oxfordshire last year, this remains in its infancy. It is our intention to enhance and grow the current R&D facilities in Abingdon wherever possible, not only in relation to its focus on composites and additive manufacturing, but also building towards becoming a global centre of excellence for the development of the exciting eDrive technology. This is in contrast to GKN's proposal with Dana for Driveline, which so far as we are aware involves no similar UK commitments and clearly aligns the future development towards the US.

Supporting Britain's industrial base

Under our ownership, the Aerospace and Driveline businesses will continue to operate under the venerable British GKN brand. We enjoy strong support on the UK equity markets, which provides access to significant funding for strategic acquisitions to grow and transform these businesses. Not only does a growing business provide the platform to support increased employment for all, but with the potential strategic options for these businesses following their improvement including a relisting, if they achieve the necessary scale, either of these businesses could return to the UK stock exchange.

Across all our businesses we understand the need for a strong and skilled workforce to power the Industrial Strategy. All the existing contractual and statutory employment rights, including in relation to existing pensions contributions, of GKN's management and employees will be fully safeguarded in accordance with applicable law.

We have outlined above our commitment to investing in R&D and to establishing a new skills, innovation and productivity fund to support the creation of 100 to 150 new apprenticeships in engineering, technology and science. Furthermore, we understand the importance of good industrial relations and have always had good working relationships with our unions. We have met with Unite as a part of this acquisition and will continue to work with them following our acquisition. As a recognition of their importance to the success of our businesses, we would be keen for them to take a seat on the Melrose Skills Board to help direct the available funds most effectively.

In respect of GKN Driveline, we intend to continue to support the automotive sector deal between government and industry, within which GKN plays an important role. This will include continued efforts to ensure the UK remains at the forefront of low-carbon and electric vehicle technology.

We are equally committed to GKN Aerospace. As well as intending to continue to support the sector deal known as the Aerospace Growth Partnership, we also intend to continue to support the Wing of the Future programme and to partner with the Aerospace Technology Institute.

We have also publicly stated the intention to work with Government to explore opportunities to promote GKN, its customers and suppliers around the world. GKN has a first-class customer and supplier base. Having already engaged with some of its key public and private sector customers during the bid period to make clear our ambitions for an improved GKN, we intend to continue to work closely with OEMs, such as Airbus, Northrop Grumman and Rolls-Royce in the aerospace sector, and with businesses including Jaguar Land Rover, Toyota, Honda and Nissan in the automotive sector, to seek further development of the UK's industrial base. We believe this will help to generate inward investment and to boost the UK economy.

The deal is also not just about GKN but its supply chain too. We intend to work with the many UK companies large and small in GKN's supply chain to drive productivity and deepen relationships. We intend to keep GKN listed as a signatory of the Prompt Payment Code.

UK tax residency

Melrose is a UK listed company and has been tax resident here since its establishment. We are wholly committed to continuing our tax residency in UK, for the period of our ownership of GKN and beyond.

Pensions

We have always been good stewards and improved the strength of every pension scheme that has come into our ownership. Our only material UK pension scheme is currently in surplus and the other smaller schemes we recently acquired with the Nortek business are well on their way. The other schemes we have held were effectively fully funded by the time we found them new, responsible and financially secure homes with Honeywell and Ontario Teachers' Pension Plan.

As you will have seen from the announcement of our agreement with the GKN Pension Scheme Trustees, our plan for GKN pensions schemes is no different.

We have agreed to pay into the GKN Pension Schemes approximately £1billion during our ownership of the business that will take them to fully funded on the basis of a discount rate of Gilts + 0.75%.

This includes a £150 million payment in the first year, split between the schemes so that the 2016 scheme is immediately fully funded to self-sufficiency. In respect of the 2012 scheme, in addition to its proportion of the initial £150 million payment, we are have committed to doubling the level of annual contributions from £30 million to £60 million a year. We are also reorganising the 2012 scheme amongst the GKN businesses, so that the liabilities better match their income profiles, plus setting a new and improved funding target on the basis of a discount rate of Gilts + 0.75%. This is twice as good as the current basis of Gilts + 1.6% and far better than the Gilts + 1.2% proposed in connection with the Dana deal.

Recognising the potentially significant sale proceeds available as we exit some of our existing businesses, we have agreed to contribute 5% of the proceeds from any existing Melrose non-GKN business and 10% of the proceeds from the sale of any GKN non-core business until the schemes are fully funded. This will mean the pension schemes are well progressed towards fully funded to their new and improved funding level prior to reviewing strategic options for the Aerospace and Driveline businesses. In any event, we have committed to ensuring the schemes are fully funded before they exit the Melrose Group.

Our £1 billion contribution to the GKN pension schemes is far more than currently promised by GKN and almost double the £525 million of deficit reduction contributions outlined in the GKN-Dana Heads of Terms agreement. Under our proposal, the deficits are likely to be recovered within five years.

Both we and the GKN pension trustees kept open lines of communication with the Pension Regulator throughout our offer process. We understand the Pensions Regulator was kept fully informed by the GKN pension scheme trustees, including being provided with copies of all documents and advice, and had a number of conversations with them throughout. We have also met with the Pensions Regulator since reaching the agreement with trustees last week to answer their further questions.

Without us, GKN pensioners would face an uncertain future under current GKN management. With the announcement of the potential sale to Dana, the approximately 3,000 members that 'win' the lottery, will be transferred to a business that has sent a UK pension scheme to the PPF in the last ten years. Those that remain behind, find themselves supported by an Aerospace business with a profit to pension liability ratio three times the FTSE 100 average. This is a very uncomfortable balance of gross pension liabilities relative to the company size and will damage the covenant of the company even if they are funded to an accounting deficit level.

National Security

We are British and work in the national interest. We understand you have the power under the Enterprise Act 2002 to intervene in transactions on the basis of national security, but we have been very clear with you and the Ministry of Defence that is not necessary in this case. We are wholly committed to securing the UK's national security.

To alleviate any concerns, we will execute a deed of undertaking in favour of the Ministry of Defence that addresses all aspects of national security.

Recognising the importance that our actions match the strength of our words, I am also committed to the continued engagement with you and your Department during the course of our ownership of GKN to demonstrate our full delivery of all these commitments.

Whatever the outcome of our bid, GKN will be a different business over the coming months. Its Board have agreed a deal which, if allowed to go through, will leave GKN Driveline as a foreign owned business, listed abroad, led and managed by a team based outside the UK. In its announcement, both GKN and Dana have been clear that they expect this new business to deliver significant savings through a range of cost cutting measures including consolidation of its sites.

We do not believe the proposed sale of GKN Driveline to Dana is in the best interests of GKN's employees, pensioners, customers, suppliers, shareholders or the wider UK economy. In fact, I would go further - it places them at risk.

We will keep working hard to ensure we secure the best possible deal for all GKN's stakeholders and the wider UK economy.

Yours sincerely,

Simon Peckham

Chief Executive

Melrose Industries plc